43,083 Average Daily Trades 21,019 Average Daily Trades · 7/16/2018 · individual corporate bonds by focusing on the following topics: 1) How the retail corporate bond market works

BondSavvy Comment Letter: Pre-Trade Transparency for Retail Investors in the U.S. Corporate Bond Market Submitted to the SEC’s Fixed Income Market Structure Advisory Committee (FIMSAC)

July 16, 2018 Public Meeting

www.bondsavvy.com © 2018 BondSavvy 1

Executive Summary

Retail investors opting to invest in individual corporate bonds – in lieu of bond funds and ETFs –

have access to a highly competitive and efficient marketplace. For each available bond, typically six to

ten dealers provide live-and-executable quotes with bid-offer spreads often tighter or comparable to

the institutional market. There are approximately 9,000 individual corporate bonds available to be

traded on any given day. While trading activity may vary by bond, there is generally sufficient TRACE-

reported trading activity in the 9,000 bonds for investors to gauge the quality of a potential bond

investment’s pricing. Coupled with retail investors’ access to full depth-of-book quotes, company SEC

financial filings, and third-party research, retail investors in individual corporate bonds have a high level

of pre-trade transparency.

Since 70.1% and 53.2% of investment-grade and non-investment-grade corporate bond trades

are under $100,000 in face value, respectively, retail investors have access to more relevant pricing data

points than institutional money managers as shown in Graphic 1:

Graphic 1: Number and Percentage of Daily Corporate Bond Trades by Trade Size – Q1 20181

Investment Grade Non-Investment Grade

Most retail investors buy between 5 to 25 bonds when they execute corporate bond trades.

There are over 100 dealers who can provide liquidity for these trade sizes and, thus, ensure a

competitive marketplace. Large buyside firms, on the other hand, need to transact in much larger sizes,

often $5 million and up, which reduces the number of potential liquidity-providing counterparties and

creates the trade-execution issues institutional firms have been trying to solve for years.

While the retail corporate bond market is robust and efficient, few retail investors are taking

advantage of it. As shown in the below AAII (American Association of Individual Investors) June 2018

1 Source: TRACE Fact Book Q1 2018 – Corporate Debt.

>=$25MM, 64 ,

0.1%

>=$1MM and

<$25MM, 4,353 , 10.1%

>=$100k and

<$1MM, 8,465 , 19.6%

<$100k, 30,201 ,

70.1%

43,083 AverageDaily Trades

>=$25MM, 13,

0.1%

>=$1MM and

<$25MM, 3,674, 17.5%

>=$100k and

<$1MM, 6,143, 29.2%

<$100k, 11,189,

53.2%

21,019 AverageDaily Trades

http://www.bondsavvy.com/




Asset Allocation survey, US investors currently allocate nearly 4x greater amounts to bond funds than to

individual bonds.

Graphic 2: AAII Asset Allocation Survey – June 2018

With smaller amounts to invest, retail corporate bond investors often have greater investment

choice since they aren’t limited to investing in the largest-sized bond issuances, as some larger funds

may be. In addition, since investors in individual corporate bonds know the issuing company prior to

investing, they can review quarterly and annual SEC filings for that issuer to assess the company’s

financial situation and the bond investment’s risk-reward opportunity. Since many bond funds and ETFs

regularly turn over their inventory – sometimes as often as 300% in a year2 – it is difficult for investors in

such funds to have a similar level of investment transparency as an investor in an individual corporate

bond.

This paper will examine the state of pre-trade transparency for retail investors investing in

individual corporate bonds by focusing on the following topics:

1) How the retail corporate bond market works

2) What tools retail investors can use when assessing individual corporate bond investments,

as shown in our case study of the Bed Bath & Beyond 3.749% ’24 bond

3) Recommendations to enhance pre-trade transparency for retail investors investing in

individual corporate bonds

2 For example, the $78 billion MetWest Total Return Bond Fund had portfolio turnover of 291% for the year ended March 31, 2018. Please see Fact Sheet here https://www.tcw.com/-/media/Downloads/MetWest_Funds/Fact_Sheets/TRB_ffs.ashx

Stock funds,

36.8%

Stocks, 31.8%

Bond funds,

12.5%

Bonds, 3.3%

Cash, 15.7%


https://www.tcw.com/-/media/Downloads/MetWest_Funds/Fact_Sheets/TRB_ffs.ashx




About BondSavvy

We founded BondSavvy to empower investors to make successful investments in individual

corporate bonds. During The Bondcast webcast series, BondSavvy makes approximately 25 CUSIP-level

corporate bond investment recommendations each year, including if and when a previously

recommended bond becomes a ‘sell.’ We also provide articles and videos that educate investors on

how to invest in corporate bonds, including The Crash Course on Corporate Bond Investing, a first-of-its-

kind video geared toward new corporate bond investors.

How the Retail Corporate Bond Market Works

Before discussing the quality of pre-trade transparency for retail investors investing in individual

corporate bonds, it’s important to understand how this marketplace works. Since this paper’s focus is

on pre-trade transparency, we will not cover every trade-execution detail but rather focus on a retail

investor’s access to a sufficient level of pre-trade information to assess potential investments.

Interestingly, as shown in Graphic 3 below, there is a significant overlap between liquidity

providing dealers in the retail and institutional market. Other than trade size, a key difference between

the retail and institutional corporate bond markets is that, while the institutional market uses a variety

of trading protocols (Request for Quote, phone, all-to-all, etc.), the retail corporate bond market is

substantially electronic with trades executed against live-and-executable quotes.

Below is a review of Graphic 3, which discusses how retail investors access corporate bond

liquidity:

Area A

Liquidity-providing dealers send live-and-executable quotes into Retail Trading Systems such as

Tradeweb direct, ICE Bondpoint, and TMC Bonds. The “bond inventory” provided by these dealers is

split into two groups:

• “Street Inventory”: Quotes provided by dealers that may or may not have a captive financial

advisor distribution network. In many cases, these dealers’ primary business is market

making and they generate revenue on the bid-offer spread. Since retail corporate bond

trading is primarily electronic, dealers grow their business by providing competitive quotes

for actively traded bonds.

• “Internal Inventory”: Retail brokerages that have large financial advisor networks often

have a trading desk that provides liquidity for the clients of the financial advisors. When a

financial advisor recommends a bond from his firm’s own trading desk, that bond is said to

be from the firm’s “internal inventory.” Note that, in many cases, this trading desk may also

be a provider of Street inventory.





Area B

With the help of the Retail Trading Systems, retail brokerages ingest bid-and-offer quotes that are then

shown to either self-directed investors or the firm’s financial advisors. Generally, the online brokerages

listed below have an ‘open architecture’ model where substantially all Street inventory is shown to self-

directed clients. Some firms are fully transparent with the quotes and show all offer-side and bid-side

quotes, while others may only show offer-side quotes pre-trade. Some firms also enable the submission

of limit orders that are inside the bid-offer spread. When these orders are submitted, they become part

of the depth of book. For example, if the top-of-book bid-offer quotes were 95 / 96, an investor could

enter a limit order to buy bonds at 95.5, and this would then be shown as a new quote that would

narrow the bid-offer spread to 95.5 / 96.

Financial Advisor Network brokerage firms may or may not allow Street inventory to be shown to their

clients, which is why we show a yellow arrow to these firms between Areas A & B. As discussed in the

Area A commentary, many of these firms have their own trading desks and may only permit orders

against that firm’s internal inventory. The level of Street inventory available to the clients of the

Financial Advisor Network brokerages varies from firm to firm.

Graphic 3: Pre-Trade Price Discovery for Retail Corporate Bond Investors

AREA A AREA B





Live-and-executable quotes

When clients of retail brokerages in Area B see a price, they expect to be able to execute a trade

at that price. This is why the dealer quotes are “live-and-executable,” meaning the dealer will fill the

order at that price 99%+ of the time. Dealers are expected to stand behind the quotes they provide, and

the retail trading systems are generally on top of policing dealer behavior to ensure efficient execution

of trades. In certain cases, the price of the bond may move as an investor moves through the trade

process, in which case, the investor would need to confirm he still wants to move forward with the trade

at the revised price.

Corporate Bond Depth of Book for Retail Investors

To illustrate how the inner workings of the retail corporate bond market benefit investors, we

show below the full depth of book available on July 11, 2018 at 9:30am for two different corporate

bonds: one investment grade (Apple 3.450% 2/9/45) and one non-investment-grade (Dish DBS Corp.

7.750% 7/1/26).

Graphic 4: Depth of Book Quotes for Apple 3.450% ’45 Bonds3

3 As of July 11, 2018 at 9:30am ET as shown on Fidelity.com.

Bids Offers

YTM Qty(Min) Price Price Qty(Min) YTM

1 3.99 250(10) 91.25 1 91.59 250(10) 3.97

2 4.00 500(2) 91.13 2 91.72 500(2) 3.96

3 4.00 125(2) 91.11 3 92.10 100(9) 3.93

4 4.01 200(2) 90.97 4 92.13 325(10) 3.93

5 4.01 100(9) 90.89 5 92.22 886(250) 3.92

6 4.03 140(10) 90.59 6 92.52 200(10) 3.91

7 4.03 300(15) 90.53 7 92.72 350(15) 3.89

8 4.04 1000(250) 90.42 8 92.83 1000(250) 3.89

9 4.05 325(10) 90.32

10 4.08 50(50) 89.85





Graphic 5: Depth of Book Quotes for DISH DBS Corp. 7.750% ’26 Bonds3

The depth of book tables show a highly competitive marketplace with narrow bid-offer

spreads. As an example, the yield to maturity bid-offer spread for the Apple 3.450% ’45 bond is only 2

basis points, which is inside the MarketAxess BASI (Bid-Ask-Spread Index) for round lots4, which stood at

3.8117 basis points on June 28, 2018. Of additional interest is that the minimum quantities (shown in

parentheses in the blue boxes) are typically two to ten bonds. This means that investors looking to buy

five bonds can often achieve similar – or even better – execution than large institutional investors.

Below is a snapshot of key data points from each depth of book table:

Graphic 6: Apple and DISH Depth of Book Summaries

Apple 3.450% ‘45 DISH DBS 7.750% ‘26 Dollar Price Bid-Offer Spread (points)

0.34 0.50

YTM Bid-Offer Spread (bps) 2 10

Bid Side # Dealers Quoting 10 10 Total Liquidity $3.0MM $2.8MM

Offer Side # Dealers Quoting 8 12 Total Liquidity $3.6MM $2.3MM

4 “Round lots” are defined as trade sizes of $1MM to $5MM. More information is available at https://www.marketaxess.com/research/basi/basi_trade_size.php.

Bids Offers

YTM Qty(Min) Price Price Qty(Min) YTM

1 9.72 610(2) 89.25 1 89.75 200(15) 9.62

2 9.73 100(5) 89.19 2 89.78 400(20) 9.61

3 9.74 250(17) 89.13 3 89.79 250(17) 9.61

4 9.75 1000(250) 89.11 4 89.81 1000(250) 9.61

5 9.75 150(15) 89.08 5 89.84 100(15) 9.60

6 9.76 5(2) 89.05 6 89.90 118(20) 9.59

7 9.76 98(2) 89.05 7 90.00 150(5) 9.57

8 9.78 200(5) 88.94 8 90.18 6(6) 9.54

9 9.79 80(20) 88.90 9 90.20 55(5) 9.53

10 9.87 315(15) 88.51 10 90.26 28(2) 9.52

11 91.62 25(5) 9.26

12 93.00 10(5) 9.00


https://www.marketaxess.com/research/basi/basi_trade_size.php




Quality of Pre-Trade Transparency for Retail Investors in Individual Corporate Bonds

We view ‘pre-trade transparency’ as transparency related to (i) the level and frequency of an

investment vehicle’s financial disclosures and (ii) investors’ ability to assess if they are receiving a fair

and reasonable price for an investment. We believe the best way for the SEC’s FIMSAC to understand

the quality of pre-trade transparency for retail investors in individual corporate bonds is through a real-

world investment example. The example we provide below shows the amount of information retail

investors can access when investing in corporate bonds.

Since BondSavvy’s first edition of The Bondcast on September 26, 2017, we have recommended

bonds of a number of brick-and-mortar retailers, including certain bonds issued by Bed Bath & Beyond

(“Bed Bath”). On May 2, 2018, we recommended purchases of two Bed Bath bonds: Bed Bath 3.749%

’24 and Bed Bath 4.915% ’34.

We had been carefully watching the performance of Bed Bath bonds, as we previously bought

the Bed Bath 5.165% ’44 bonds and, for quite some time, Bed Bath had the distinction of being among

the highest-yielding investment-grade corporate bonds.

Information We Accessed To Evaluate the Bed Bath Investment

To simplify our Bed Bath case study, we will focus on the ’24 series bonds we recommended

May 2. The company reported earnings on April 11 for the 53-week period ending March 3, 2018. As

shown in Graphic 7, the ’24 bonds had been trading in a range between 96 and 106 since the bonds

were issued on July 14, 2014. The bonds continued to trade in the mid-90s following the April 11

earnings release.

Then, on April 18, S&P downgraded the bonds to BBB-, the lowest investment-grade rating,

which caused the bonds to fall 10 points down to the mid-80s.

Graphic 7: Bed Bath 3.749% ’24 Price Performance Since Issuance5

5 Source: FINRA Market Data.





Many investors immediately sell bonds upon a downgrade, which is exactly what happened with

the Bed Bath ’24 bonds. What most investors weren’t paying attention to was that, in spite of its recent

struggles, Bed Bath has (i) a limited amount of indebtedness relative to its earnings and (ii) high interest

coverage (Earnings before Interest, Taxes, Depreciation & Amortization (EBITDA) divided by interest

expense).

Below is a review of the publicly available information we evaluated when considering the Bed

Bath ’24 investment:

1) Bed Bath’s April 11 earnings release and analyst call

2) S&P’s April 18 downgrade note

3) Financial information and bond-trading data pertaining to Macy’s, a good comp for Bed Bath

4) Bed Bath’s Form 10-K filing on May 2

5) News stories pertaining to Bed Bath

6) Historical bond prices as shown in Graphic 7

7) Full depth of book quotes available on April 30

• There were between six to eight dealers providing bid-offer quotes on the Bed Bath

’24 bonds, and the top-of-book quote on April 30 at 12:00pm ET was 85.39 / 85.75

8) Trade by trade TRACE data reviewing 1,267 trades executed between April 17 and May 2

(see excerpt of data in Graphic 9)

Prior to assessing the pricing quality of the Bed Bath ’24 bond, we needed to gain comfort that

the company had the ability to pay off the ’24 bonds at maturity. We know from Bed Bath’s 10-K that it

has three bonds outstanding:

• $300MM in Bed Bath 3.749% ‘24

• $300MM in Bed Bath 4.915% ‘34

• $900MM in Bed Bath 5.165% ‘44

We like the ’24 series bonds since they represent the company’s first bond maturity and it is

only $300MM in size. As shown in the below table, Bed Bath had $1.145 billion in fiscal-year 2017

(ending March 3, 2018) EBITDA and $724MM of cash and short-term investments, strong numbers that

support repayment of the ’24 bonds.

In investment-grade corporate bonds, both Macy’s and Bed Bath have had some of the highest-

yielding bonds. Therefore, in Graphic 8, we compare Bed Bath’s financial picture to that of Macy’s and

then evaluated how Macy’s and Bed Bath’s bonds traded relative to each other.

While Bed Bath’s EBITDA has taken a big hit over the last year, much of this has been driven by

its growth in digital revenue and the lower margins associated with that business. Bed Bath’s overall

revenue growth had been stronger than that of Macy’s, and we believe a lot of this is driven by the focus

on digital revenue at Bed Bath, which we viewed as a long-term positive. In addition, while both





companies have reasonable leverage and high interest coverage ratios, Bed Bath is stronger for both

metrics as shown in Graphic 8:

Graphic 8: Financial Comparison of Bed Bath to Macy’s6

After evaluating the financials of both companies, we examined how the bonds of Macy’s and

Bed Bath were trading. We compared a variety of bonds with different maturities, including Macy’s

5.125% 1/15/42 bond to the Bed Bath 5.165% 8/1/44, where the Bed Bath bond’s spread to Treasury

was 128 basis points wider than that of the Macy’s bond (3.20% for Macy’s vs. 4.48% for Bed Bath). The

Bed Bath ’24 bond had a spread to Treasury of 3.68%, which was a premium to many non-investment-

grade corporate bonds.

We review this Bed Bath ’24 case study not just to show how we do our analysis, but to show

the level of information available to retail corporate bond investors. It’s why we believe pre-trade

transparency for retail investors investing in individual corporate bonds is strong.

One Final Check Before Investing

As previously discussed, the top-of-book quote for the Bed Bath ’24 bond was 85.39 / 85.75 on

April 30 at 12:00pm ET. There had been significant trading activity in this bond, including 114 trades on

April 30 and 186 trades on April 25, even though the bond has a relatively small $300 million issuance

6 Source: Company SEC filings and earnings releases

$ in millions except per-unit amounts

Macy's Bed Bath

Revenue

2017 $24,837 $12,349

2016 $25,778 $12,216

YOY Growth -4% 1%

EBITDA

2017 $3,089 $1,145

2016 $2,950 $1,494

Growth 5% -23%

Margin 12% 9%

Comparable Sales (YOY) (2.2)% (1.3)%

Free Cash Flow $1,184 $484

Interest Expense $321 $66

Debt 5,883 1,492

Cash & Short-Term Investments 1,455 724

Leverage Ratio (Debt/EBITDA) 1.9x 1.3x

Interest Coverage (EBITDA/Int Exp) 9.6 17.4





size. To ensure the dealer quotes aligned with actual trades, we compared the dealer quotes to recent

TRACE trades as shown below:

Graphic 9: Select TRACE Data for Bed Bath ’24 Bonds – April 30, 2018

When reviewing TRACE data, we focus on dealer-to-dealer trades, which we have boxed in

green, as they would not include any customer mark-ups or mark-downs and would reflect the ‘true’

price of the bond. As shown above, the dealer-to-dealer trades were generally priced higher or very

close to the quoted offer price we saw on Fidelity.com at 12:00pm ET on April 30, 2018. We therefore

had final confirmation that we were buying the bonds at a compelling price.

Performance of the Bed Bath ’24 Bond

With the high levels of pre-trade transparency in corporate bonds, we believe it is possible for

retail investors to uncover corporate bond investments that can achieve strong returns. An example of

this is the Bed Bath ’24 bond, which has achieved strong performance relative to industry benchmarks

as shown below:

Graphic 10: Comparison of Bed Bath ’24 Total Return to Corporate Bond ETFs

Investment

April 30 Offer Price Post Mark-up7

Statement Price On July 11 ‘18

Total Return Apr 30-July 11 ‘18

Bed Bath 3.749% ‘24 85.850 91.665 +7.63%

iShares LQD8 N/A N/A +0.74%

iShares MLQD9 N/A N/A +0.89%

7 Assumes $1 per bond mark-up on the price quoted 8 LQD is the iShares iBoxx $ Investment Grade Corporate Bond ETF 9 MLQD is the iShares 5-10 Year Investment Grade Corporate Bond ETF





Pre-Trade Transparency Advantages over Bond Funds and ETFs

Today, in many respects, a retail investor investing in individual corporate bonds is investing in a

more transparent investment than a bond fund or ETF for the following reasons:

1) Investors know the specific security in which they are investing and can evaluate that security’s

risk and potential return

2) Financial disclosures made by bond-issuing companies are generally more comprehensive and

frequent than those made by bond funds and ETFs

3) Most bond funds are not pure-play corporate bond funds, which makes it difficult to understand

exactly what you are investing in, especially since many of these funds are permitted to own

equities and regularly turn over their bond inventories

4) Since individual bonds trade as a percentage of their face value, it is easier to understand the

relative value of the bond and its potential upside. This is more difficult to do with bond funds,

which don’t trade relative to a par value and trade more like a stock. Individual corporate bonds

all trade on the same scale.

Recommendations To Improve Pre-Trade Transparency in Corporate Bonds

While the above factors can work to the advantage of retail corporate bond investors, there are

a number of ways market participants could help further improve pre-trade transparency for retail

investors in individual corporate bonds. These include:

1) Enhance and more broadly distribute historical price graphs for corporate bond CUSIPs

2) Educate investors on the rationale of selling bonds prior to maturity

3) Modify the bond prices seen on client statements to better reflect the bond’s market value

4) Further educate investors on the pros and cons of owning individual corporate bonds compared

to bond funds and ETFs.

Following is a detailed review of these recommendations:

Recommendation 1

Enhance and more broadly distribute historical price graphs for corporate bond CUSIPs

Graphic 2 showed that, while investors in the AAII Asset Allocation Survey allocated nearly 4x

more of their investments to bond funds compared to individual bonds, allocation to stocks (31.8%) was

fairly even with that of stock funds (36.8%). This is cause for concern since there are key advantages of

owning individual bonds over bond funds, such as receiving a fixed coupon and an investor’s principal at

maturity, and these advantages only relate to individual bonds – not individual stocks.





Many investors believe owning individual corporate bonds is too difficult to understand and that

it’s an opaque market. We believe we can begin changing this perception by better equipping retail

investors with tools to assess the value at which they are buying a security.

Prior to buying stocks, investors often look at historical stock price charts to gauge the price

momentum of a stock and to see where they are buying the stock relative to its historical performance.

Retail corporate bond investors, on the other hand, are presented with TRACE data in a table format

that can be difficult to digest and quickly get a read on the performance of the bond as shown below:

Graphic 11: FINRA TRACE Historical Bond Prices for Bed Bath 3.749% ‘24

Rather than getting an immediate snapshot of a bond’s long-term performance, investors must

tediously page down to see all the different prices of the bond and decipher which type of trade it is:

Dealer to Dealer, Customer Buy, or Customer Sell. This is a daunting task for experienced investors and

keeps investors from being able to gain a more comprehensive understanding of a bond’s pricing

history.

While historical bond price charts are available on the FINRA market data site located at

http://finra-markets.morningstar.com/MarketData/Default.jsp, only a select number of investors know

where these charts are and the charts themselves have limitations. Graphic 12 shows a bond price chart

for Bed Bath & Beyond 3.749% ’24 bonds:


http://finra-markets.morningstar.com/MarketData/Default.jsp




Graphic 12: Bond Price Chart for Bed Bath 3.749% ‘24

We propose three key changes with respect to these historical pricing charts:

1) Increase Usage of Price Charts: Encourage brokerages to complement their table-formatted

TRACE data with the FINRA historical price charts, as the charts are more user-friendly and

make it easier to view trade history over a much longer time period.

2) Have Chart Prices Reflect Dealer-to-Dealer Trades: Make the prices depicted on the chart

for each trading day to be that day’s last dealer-to-dealer trade. Currently, the charts show

the “Last Trade Price,” as circled in green above. Often times, this price can be distorted as

the result of a large markup on a bond. When this price is shown in the above chart, it looks

like there is a spike in the price of the bond, when, in fact, it was the result of a two-point

markup. As shown in Graphic 11, there were numerous trades before the 94.63 (boxed in

green) trade that ranged between 91-92. Then, at 16:58:52, there were two 12-bond trades

reported: 1) a dealer-to-dealer trade at 92.663 and 2) a dealer-to-customer trade at 94.63.

In this case, a retail brokerage bought the bond from Street inventory for 92.663 and then

sold the bond to its client at 94.63, a nearly two-point markup.

In light of all of this, the price shown in the chart should either be 92.663, or, alternatively, a

volume-weighted average price of a day’s final trades, depending on the volume of the

bond.

3) Add a Spread to Treasury Chart: To provide further insight into what is driving pricing

movements in corporate bonds, we recommend adding an additional chart tab where the

blue circle is located in Graphic 12. In this tab, we recommend a chart showing the spread

to the comparable Treasury (“credit spread”), so investors can see how a bond’s credit





spread has changed over time. Institutional investors have access to these data, and retail

corporate bond investors should be put on a level playing field.

Many investors believe that the only driver of bond prices is interest rates. This has kept

many potential bond investors on the sidelines given their fear of ‘rising rates.’ Providing

spread data not only helps investors see the positive or negative direction in which credit

spreads have been trending but also enables investors to compare one bond’s credit spread

to that of another.

Recommendation 2

Educate Investors on the Rationale of Selling Bonds Prior to Maturity

A large portion of retail investors owning individual bonds creates a bond ladder and, typically,

holds their bonds until maturity. We believe this negatively impacts market liquidity, investor choice,

and investor returns.

Graphic 13 shows the range of investment-grade corporate bond prices from a recent online

brokerage search. In this chart, we see the largest concentration of bonds is priced between par (100)

and under 110. There is then a split of bonds priced at i) 110 or above and ii) below par:

Graphic 13: Range of Investment-Grade Corporate Bond Prices10

A key benefit to investing in individual corporate bonds is that all bonds trade on the same scale.

They all have the same par value and investors can assess the value of one bond and readily compare it

10 Data from corporate bond search conducted on Fidelity.com on March 29, 2018 that included 2,092 bonds with yields to maturity of at least 4%.





to another. This scale can also help inform investment decisions, as we see that bond prices cannot go

up without an upward bound as stock prices can. In this chart, we see only 9 out of 2,092 bonds have

prices at or above 150, an effective ceiling on corporate bond prices.

In light of this ceiling, we believe it is important for investors to consider selling bonds prior to

maturity to the extent they believe little upside remains in a bond. For example, if an investor bought a

bond due in 2024 at par and the price increased to 130 over the next two years, we believe the investor

should consider selling that bond rather than waiting another four years to get par when the bond

matures. If more retail investors considered this approach, there would be greater secondary market

trading activity. This availability of additional bond inventory would help increase price competition,

grow investor choice, and help shrink bid-offer spreads.

We therefore propose that: 1) Retail brokerage firms consider broaching the topic of clients

selling bonds prior to maturity when deemed appropriate by the brokerage firm; and 2) That FINRA-led

investor education programs pertaining to corporate bonds discuss this alternative to investors creating

a traditional bond ladder.

Recommendation 3

Make Client Brokerage Statement Pricing More Reflective of Market Prices

Many bond investors become alarmed when they buy a bond for 98 and then, when they see

the price of the bond on their brokerage account the following day, the bond has a price of 97 even

though the actual price of the bond has not changed. The reason for this is that the brokerage

statement shows the bond at the bid price (the price at which a bond can be sold) rather than the price

at which a bond can be bought. This is a challenge for stock investors who may consider corporate bond

investments but are used to bid-offer spreads of one penny. Such investors often have difficulty coming

to grips with a reduction in the value of a security due solely to the bid-offer spread.

While we agree that the bid price of the bond should be shown in client statements, we believe

that the price should better reflect the market value of the bond rather than an ‘evaluated price,’ which

is more applicable to lightly traded bonds and for institutional trade sizes.

In many cases, the evaluated price is lower than the bid price at which a retail corporate

bondholder could sell his bonds. This gives investors the impression that bid-offer spreads are wider

than they actually are and, in many cases, understates the value of client portfolios. We believe this

makes retail investors less likely to invest in – and regularly trade – individual corporate bonds.

We propose that: if there is a live-and-executable quote available to a retail brokerage client

that can satisfy the quantity of bonds owned, that this price becomes the price reflected on the client

statement. If such a quote is not available, then the status quo evaluated price should be used.





Recommendation 4

Further Educate Investors and Advisors on the Pros and Cons of Individual Corporate Bonds

Placing retail investors into bond funds and ETFs rather than individual bonds is often more

lucrative for the financial services industry. These products provide a significant recurring revenue

stream. According to Morningstar’s “US Fund Fee Study,” the average 2017 management fees for active

and passive taxable bond funds were 0.66% and 0.18%, respectively11. If we assume the average taxable

fund charges a 0.50% management fee and the average fee-based financial advisor charges 1.00%, this

would result in an investor using a financial advisor to be paying 1.50% of taxable bond fund assets in

fees. If we further assume a 4.5% annual rate of return on a taxable bond fund (after the 0.50%

management fee), the brokerage and fund’s share of the client return is 30%12.

Given this large share of an investor’s return going to someone other than the investor, it’s

important to understand whether this current market structure is in the best interest of retail investors.

Even though only a small number of retail investors own individual corporate bonds, there is a robust

and competitive market available to trade these securities. This marketplace can become even stronger

if more retail investors become comfortable investing in individual corporate bonds.

We propose that: Retail brokerages make a bona fide effort to educate clients on the pros and

cons of owning corporate bonds directly compared to through a bond fund or ETF.

Certain brokerages have hosted investor education webinars related to individual corporate

bonds, and we applaud these efforts. Today, individual corporate bonds are a highly underrepresented

retail investor asset class. We believe investors become empowered when they understand a wider

variety of investment options and can decide which investment vehicles are best suited to their needs.

With greater investment choice comes increased competition and innovation, all of which would be

strong positives for the US corporate bond market.

11 US Fund Fee Study, April 26, 2018. 12 Calculated by taking 1.50% of 5.00%, which is the fund’s assumed return before the 0.50% management fee.


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43,083 Average Daily Trades 21,019 Average Daily Trades · 7/16/2018 · individual corporate bonds by focusing on the following topics: 1) How the retail corporate bond market works